Partnerships

When two or more people agree to maintain a business for profit, it is considered to be a partnership. A partner may contribute money, expertise, time or energy to help the business grow and expects to receive a share of the profits in return. The potential for business success may be increased if each partner brings a unique set of capabilities that are complementary.

A partnership is similar to a sole proprietorship, but it allows more than one person to share in the ownership of the business. There is no legal separation between the business and the owners, and as with a sole proprietorship, there is less paperwork than there would be with a corporation.

Since a partnership does not file papers with the state as with a corporation, does that mean there is no paperwork?

You still need to get all required permits and licenses from the federal, state and local governments. You might need to register the business's name with your state. (It may be called an Assumed Name Certificate.) If you are hiring employees, you will need an employer identification number (EIN) from the Internal Revenue Service, and you may need to register as an employer with your state.

Do we really need a partnership agreement?

Although a partnership is simple to form, many business advisors believe it is one of the most difficult to keep going. There is no legal requirement, but experts recommend that a formal partnership agreement or contract be completed. The contract should define the duties and responsibilities of each partner, how much time each partner will devote to the business and how profits will be divided. The amount and kind of capital contributed by each participant should be recorded.

A partnership agreement should also deal with how the partnership may be split up-the process for one partner being bought out by the remaining partner or partners or division of assets if the business is later dissolved for any reason. An enterprise should not be started unless everyone is optimistic that it will succeed, but it is to each partner's advantage to anticipate a change in ownership or time devoted to the business.

What else should be in a partnership agreement?

You might want to include how to handle profit-sharing; it would be assumed to be an equal split unless otherwise specified. You can also agree to the process for removing or adding a partner so that the partnership does not get dissolved. A method for appraising the assets of the partnership should be specified in the agreement.

Why should I consider the partnership form of business?

One of the primary reasons people choose to start their business as a partnership is that there is no initial governmental paperwork, so it is simple and straightforward. (Remember, however, partners need to have a clear understanding of what each will contribute to the business, and that understanding should be in the form of a written agreement.)

As partners need to raise capital for their business, they may be able to present a stronger case for loans or simply have a wider network to draw on for funding resources. Also, in order to attract high-quality employees, the firm can offer the opportunity to become a partner.

What are the problems with a partnership form?

The partnership form shares some of the drawbacks of the sole proprietorship as well as some additional shortcomings.

Liability is a significant issue. Each partner is liable for the actions of the other. For example, business debts incurred by one person become the responsibility of all partners. Decisions such as how to share profits, as well as differences on how to manage the business, can trigger disagreements.

A partnership does not have a perpetual life. It can end when a partner leaves, either voluntarily or through death or disability.

How do taxes work for a partnership?

Generally, tax treatment for a partnership is similar to a sole proprietorship. Profits from the business are taxed at the partners' personal tax rates, rather than the typically higher corporate tax rate.

Benefits such as health insurance cannot be deducted by the partnership, and they become part of the personal tax schedule of the partner.

What are the different types of partnerships?

Besides the general partnership that has just been described, there are two other types of partnerships.

Limited partnership

Like a general partnership, a limited partnership is made up of two or more people who agree to own and operate a business. The difference is that one or more of the partners does not manage the business and has limited liability. There must also be at least one general partner.

In addition to meeting the requirements of a general partnership, a written agreement is required and the words "Limited Partnership" must be included in the name. Your state will most likely require that you file a Certificate of Limited Partnership and keep certain records.

The partnership files an information return annually, but income or loss flows directly to the partners. Partners report their share of the profit or loss on their individual income tax returns.

Joint venture

A third type of partnership, the joint venture, is set up for a special purpose and has a limited time frame. A corporation can be the "person" in the partnership, and joint ventures can be combinations of large corporations as well as small businesses.